Sound Money Blog

Calling the Fed’s Bluff

Posted by Gonzalo Schwarz
January 10, 2013

by Devin Roundtree

Currently, the Federal Reserve is buying $45 billion in Treasury bonds in addition to $40 billion in mortgage backed securities a month. If you do the math, you end up with $1,020 billion on an annual basis. In order to calm inflation fears, the Fed claims that it can put the brakes on the printing press if the unemployment rate improves, or if prices get out of hand. But such talk is merely a bluff.

Interest rates in the U.S. have remained at historic lows over the last two years thanks to European investors fleeing to the perceived safety of U.S. Treasuries. But what happens if interest rates rise? The average maturity of government debt held by the general public stands at five years and the historic average yield on a 5-year treasury note is 6.45%, compared to today’s rate of .825%. As of November, the national debt sits at $16.4 trillion, $11.6 trillion of which is owed to the general public. If the government had to pay the average rate on its debt, interest payments to the public would be $750 billion compared to the $130 billion that the government currently pays on the entirety of its debt. But if the government had to pay an average rate of 12% like it did the last time interest rates spiked in the early 1980s, interest payments on publicly held debt would explode to almost $1.4 trillion; revenue currently stand at about $2.5 trillion. Never before has America’s economy been so indebted and thus so dependent upon low interest rates. If rates returned to historic averages, tax revenues could easily fall by $1 trillion.

Ben Bernanke wasn’t able to see the biggest economic bubble in America’s history during the housing boom, but he certainly can do basic math. It matters not what the unemployment rate is, or how much prices are rising, there is no way Bernanke can substantially increase interest rates without bankrupting the federal government. If Bank of America is too big to fail, the federal government certainly qualifies. But attempting to keep interest rates low indefinitely by recklessly inflating the currency and devaluing the Dollar, only guarantees that market rates will skyrocket in the years to come.

No matter how bad the debt crisis is in Europe, the situation is incomparable to the United States, and even the Europeans are beginning to realize that. After a 14 month slide against the Dollar, the Euro has been back on the uptrend since late July and its beginning to take interest rates on U.S. Treasuries along for the ride. Inevitably, the government is going to go bankrupt. But instead of filing Chapter 11, the Fed will inflate to payoff America’s creditors. The Fed is currently the biggest buyer of Treasuries, but in order to keep government spending afloat it will have to become the only buyer. This is why a currency crisis is all but a foregone conclusion.

Devin Roundtree received his M.A. in economics from the University of Detroit Mercy.

image: flickr.com/chaps